Bailout exit likely to lack comfort of ESM clarity

After two days of talks between European finance ministers in Dublin Castle, it is clear that the euro zone powers expect Ireland to exit the bailout at the end of this year without any specific promise of aid from the European Stability Mechanism to ease the cost of rescuing AIB and the Bank of Ireland.

As Minister for Finance Michael Noonan struck a deal on Friday to postpone €42.5 billion in loan repayments to Europe by seven years, he made a point of saying the framework for ESM bank recapitalisations will be the final part of the jigsaw to be settled.

“There are still outstanding issues and I wouldn’t expect the ESM to be directly recapitalising banks in whatever way the rules are drawn up to enable them until next year and not in January,” the Minister told reporters. “There’s a sequence . . . of putting the major pieces in place and the financing by the ESM is the last piece that has to be put in place and the guidelines on how it actually operates have not yet been drawn.”

Among European officials in Dublin at the weekend, the sense was that these vexed questions are not going to be settled before the Irish bailout ends. Indeed, the campaign to engineer a smooth return to private investors is seen to be quite separate from the debate over the ESM’s powers.

Market re-entry
This reflects the argument that the Anglo promissory note deal and the extension of loan maturities should be sufficient to regain market access. That idea will be tested in real time in the coming months.

With the external situation still uncertain in light of the Cypriot debacle and political stasis in Italy, the hope must be that relative calm prevails in financial markets. However, that is something over which Dublin has no control.

While Dublin still clings rigidly to the solemn pledge by EU leaders to break the loop between bank and sovereign debt, the promise will not be fulfilled for some time yet. Among the ranks of jaded euro zone officials, the objective remains to pin down the basic features of the direct recapitalisation scheme by a June deadline set by EU leaders. But determination must still overcome acute scepticism in Berlin, Helsinki and The Hague, and the sense is that Ireland and other potential beneficiaries such as Spain will have to wait until later for the fine grain.

The problems are legion. Still at issue is the politically charged question of retrospective aid to compensate member states for recapitalisations made in light of past losses. Also under discussion are the precise eligibility criteria for ESM interventions in banks.

Further uncertainty surrounds the evolution of the scheme alongside parallel talks on an initiative to resolve stricken banks in which bondholders and large depositors will be expected to contribute to rescue costs. Another point on which clarity is absent centres on the exact amount the ESM might set aside for direct bank recapitalisation.

Mushrooming issues
Each question here raises a clutch of others, meaning new issues seem to surface all the time. For example, German minister Wolfgang Schäuble left Dublin on Saturday afternoon saying stricken banks should be recapitalised first by their home country before any drawdown of capital directly from the ESM.

This was cast as yet another German roadblock, although it was always likely that contribution from the member states would be sought before the ESM steps in. The question of what actually constitutes a sustainable burden for the member state concerned is therefore crucial.

The essential message from Schäuble was to reinforce the sense of deep German unease at the very idea of the ESM rescuing banks directly. With chancellor Angela Merkel facing into a general election in September, it would be unwise to bet on a breakthrough before then.

For a flavour of the mood in Germany vis-a-vis the ESM look no further than the business paper Handelsblatt which reported before the Dublin talks that the negotiation had reached a virtual standstill. "The discussions are going in circles," said an EU diplomat quoted by the paper .

This was before Germany sought and received an agreement in Dublin to examine whether a further change to the EU treaties is required to underpin the system in which the European Central Bank will supervise large commercial banks from next year. With the new ECB powers a prerequisite for direct ESM recapitalisations, any reopening of the treaties is bound to cause further delay.

It follows that Mr Noonan should not count on the ESM jumping in soon to lessen the burden on the State from AIB and the Bank of Ireland.